Andrew Podger and Peter Whiteford. Inequality and Australia’s Welfare System

Policy Series

Inequality is a complex issue. It is affected by many factors, so that it can increase as a result of beneficial changes as well as socially undesirable ones, and can decrease because of changes that reduce overall social wellbeing as well as a result of socially desirable changes. A particular level of inequality may not therefore be suitable as a policy target per se as distinct from such specific objectives as alleviating poverty, increasing employment, achieving a fair taxation system or improving levels of participation and engagement in society.

In our submission to last year’s Senate Inquiry into Inequality we summarised trends in Australia over the last 30 years but suggested the Committee focus its attention on promoting employment and addressing specific weaknesses in the tax and transfer system. These might deliver some of the savings the Government has been seeking but would also involve some new expenditure priorities.

Trends in income levels and disparities

Average real incomes of Australians have increased substantially over the last 30 years, but with some periods of slow growth and others of very rapid growth. Employment patterns have also changed with periods of increasing unemployment and periods of reduced unemployment; overall, employment has grown strongly in the second half of this period, but accompanied by growth in part-time employment and casual work.

The periods of high unemployment were associated with increases in inequality. Some family changes reinforced these negative trends, and Australia developed an extremely high concentration of joblessness in households with no adults in paid employment.

The increases in real disposable incomes for Australian households since the recovery from the 1990s recession were greater than in any period since the 1960s. After Ireland – and from a much higher base – Australia enjoyed the largest real increases in mean and median real incomes of any OECD country, and since 2008 Australia has continued to move ahead at a faster rate than many countries in Europe or the United States.

The richest 10 per cent of Australian households, however, enjoyed the largest real increase in household disposable incomes of any OECD country and, since the incomes of the richest increased faster than the incomes of lower income groups, income inequality increased. The overall trend on virtually all measures of resources is towards greater inequality in the period up to 2008.

The causes of these trends are complex. The most important source of income inequality in Australia is related to access to earnings, since earnings are the largest single component of household incomes. As mentioned, high unemployment has a major impact on the level of overall inequality and disadvantage.

A related factor is inequality of earnings for full-time workers which have tended to increase almost continuously since the 1970s, as a result of modest real wage increases at the bottom of the earnings distribution, a hollowing out of middle level jobs and growth in the number and wages at the top of the distribution. This is broadly consistent with international experience.

These disparities were partly offset in Australia by rising real wages for women (although gender wage gaps have increased since around 2004, so that overall little progress has been made to reduce these gaps since the mid-1990s). In earlier periods rising employment for women tended to increase family income inequality as the growth was concentrated amongst families with a relatively high male income earner, but over the last decade rising female employment has tended to reduce overall inequality (Austen and Redmond, 2012) .

Changes in family composition and the demographic structure of the population appear to have reinforced trends towards rising inequality, but the effect is much less important than access to employment.

One of the more striking features of recent Australian experience is that after 2000 inequality in market incomes actually decreased (Herault and Azpitarte, 2014) . This positive trend appears to reflect the equalising effect of growth in employment for lower income groups in this period. But this also means that increased inequality in disposable incomes over the period up to the Global Financial Crisis was a consequence of government policies becoming less effective in reducing inequality.

The tax and transfer systems are important mechanisms by which Australian governments have acted to moderate inequality in market incomes particularly to alleviate poverty, and also to offset rising inequality. The effectiveness of taxation and social security systems (and social spending more broadly) in reducing inequality reflects two factors – the distribution of taxes and benefits (i.e. how progressive are the tax and welfare systems) and how large they are as a share of household income. In this context, it should be noted that while levels of social spending in Australia are towards the lower end of OECD countries, the social security system is the most progressive in the OECD.

The effectiveness of the tax and transfer systems in reducing inequality reached its peak in the mid-1990s and subsequently declined. The decline in the effectiveness of the tax and transfer systems in reducing inequality is partly explained by some transfers such as Newstart not keeping pace with rising community incomes (this being particularly important for alleviating poverty), but it also reflects the fact that the Australian social security system is very targeted to lower income groups so, as the earnings of lower income households increased due to higher employment levels, the social security benefits they received reduced.

Because Australia has the most progressively distributed social security benefits in the OECD, per dollar spent Australia reduces income inequality more than any other country (but we spend fewer dollars). Correspondingly, across the board cuts in social security in Australia would increase inequality by more than any other OECD country (OECD, 2012). This makes achieving further expenditure restraint in Australia a particularly difficult challenge – although it contributes to the outcome that overall we have relatively low social security spending.

Design principles for Australia’s social security system

There are strengths in the Australian social security system design and its emphasis on poverty alleviation. That remains the central objective. But this objective needs to be balanced against other objectives, particularly the objective of encouraging work and savings and self-help more generally, noting the longer-term advantages of employment including the avoidance of persistent poverty and disadvantage.

Getting the right balance is a matter for judgment, but we suggest the following general principles should be applied in the design of our social security (and related tax) system:

Limiting eligibility for the major social security payments to those unable to find work or not expected to work;

Distinguishing between those with long-term constraints on capacity to work and those in shorter-term need, with eligibility conditions for the latter that promote employment and rehabilitation, and policies for the former that facilitate supplementation of social security payments by income from savings or part-time and occasional work;

Setting adequacy standards that ensure those totally dependent on social security (and who meet all the conditions mentioned above) do not live in poverty defined in terms of minimum incomes relative to Australian community standards. This also means that the payment rates for those unable to find work should be the same as for those not expected to work;

Applying means tests that leave reasonable incentives to work and save while concentrating assistance on those most in need, the means test on those with longer-term constraints on working being tapered so that effective marginal tax rates are not excessive, and the test for those with shorter term needs designed on the expectation that the basic eligibility conditions will provide the main incentive to gain and sustain employment;

Linking assistance for those outside these categories primarily to assistance for dependent children in recognition of their direct costs and the costs (both direct and indirect) of their care, this assistance addressing both vertical equity (providing greater support to lower income families) and horizontal equity (recognising that the costs of children affect capacity to pay tax at all income levels);

Preserving redistributive capacity in the tax system, primarily through the personal income tax threshold which should exceed the maximum level of pensions, but also through marginal tax rates that increase at higher income levels.

Some specific priorities

From these principles we suggest the following practical measures to achieve expenditure restraint while simultaneously addressing concerns with inequality:

Indexing all social security payments by a common factor that will preserve relativities including with changes in community incomes. The current pension index is likely over time to increase pensions relative to community disposable incomes and raise longer term budgetary challenges, but indexing to the CPI alone would inevitably lead to social security recipients falling behind over time, as shown by the experience of Newstart recipients. This is a genuine policy dilemma but the current compromise reflects policy failure on both sides of politics, allowing overly generous indexation of pensions and continuing miserly attitudes towards the unemployed and sole parents in particular. We suggest the CPI as an automatic adjustment factor for all transfers and biennial independent reviews to determine supplementary adjustments in light of changes in average community incomes, with a legislative requirement that these reviews be debated in Parliament.

Additional increases in Newstart to reduce the gap between the different categories of payment, as a complement to a more effective package of support services and incentives to promote employment.

Redesigning family payments into a more coherent framework which addresses both horizontal and vertical equity, leaving to private financing any income-related support such as paid parental leave (while maintaining the current flat-rate structure).

Increasing the personal income tax threshold as part of a package to simplify personal income tax as suggested by the Henry Review, and reviewing the income levels where higher marginal rates are applied, particularly if some family payments are to be paid on a universal basis.

We also suggest a comprehensive review of retirement incomes policy to allow careful consideration of the effectiveness and efficiency of current arrangements, including inter alia tax expenditures and the age pension means test. This might avoid the inevitable adverse effects of the piecemeal approaches now being put forward by the Government and Opposition.

The specific measures above would deliver some of the savings proposed by the Government, but would also involve higher expenditures in some areas. If some of these measures are considered too hard in the current budgetary climate, we suggest a new review of the adequacy of the full range of social security payments using the same methodology as the Harmer Pensions Review (which, because it was restricted to consideration of pensions and related allowances, contributed unintentionally to some of the current inequities within the social security system).

Andrew Podger is Professor of Public Policy at the ANU and former Head of several Commonwealth departments. Peter Whiteford is a Professor in the Crawford School of Public Policy at the ANU.